Question

Parramore Corp has $12 million of sales, $3 million of inventories, $2.5 million of receivables, and $1 million of payables. Its cost of goods sold is 85% of sales, and it finances working capital with bank loans at an 8% rate. Assume 365 days in year for your calculations.

1. What is Parramore's cash conversion cycle (CCC)? Do not round intermediate calculations. Round your answer to two decimal places.
   days
2. If Parramore could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be the new CCC? Do not round intermediate calculations. Round your answer to two decimal places.
   days
3. How much cash would be freed up, if Parramore could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold? Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000. Do not round intermediate calculations. Round your answer to the nearest dollar.
   $  
4. By how much would pretax profits change, if Parramore could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold? Write out your answer completely. For Example, 13.2 million should be entered as 13,200,000. Do not round intermediate calculations. Round your answer to the nearest dollar.
   $  

Answer 1

1.Cash Conversion Cycle (CCC)=Days of Inventory Outstanding (DIO)+Days of Sales Outstanding(DSO)+Days of Payable Outstanding (DPO)

Days of Inventory Outstanding (DIO)=(Inventory/Cost of goods sold)*365

Inventory =$3 million

Cost of goods sold =85%*12=$10.2million

DIO=(3/10.2)*365=107.35 days

Days of Sales Outstanding(DSO)=(Accounts Receivable/Sales)*365=(2.5/12)*365=76.04 days

Days of Payable Outstanding (DPO)=(Accounts Payable/Cost of goods sold)*365=(1/10.2)*365=35.78 days

CCC=DIO+DSO-DPO=107.35+76.04-35.78=147.61 days

2. New Inventory =(1-0.1)*3=$2.7million

New Receivable =(1-0.1)*2.5=$2.25million

New Payable =(1+0.1)*1=$1.1million

New CCC=(2.7/10.2)*365+(2.25/12)*365-(1.1/10.2)*365=96.61+68.44-39.36=125.69 Days

3.Cash Freed up:

Cash freed up by inventory reduction=(3-2.7)=$0.3million

Cash freed up by reduction in receivables =(2.5-2.25)=$0.25 million

Cash freed up by increase in payables =(1.1-1)=$0.1 million

Total Cash freed up =0.3+0.25+0.1=$0.65million

Cash Freed Up=$650,000

4.Pretax Profit will increase by (650000*8%)=$52,000

Pretax Profit will increase by reduction of interest expense on working capital